Hedging risk through dynamic short exposure

AGEFI Indices - Some lingering uncertainties on the markets could see investors reduce risk in their equity portfolios

While global financial markets chalked up 9% gains over the first six months of the year, a number of investors are spotlighting the high valuations of stocks along with the intrinsically increased risk of their portfolios. On top of this, some uncertainties, which include the trouble in predicting the budgetary and regulatory policies of the Trump administration, could weigh on the markets in the near future. With this in mind, being able to anticipate and manage bearish trends on the equity markets regardless of their timing and magnitude could prove to be key and ultimately improve the risk/return profile of a global portfolio.

It is possible to offer investors a low-cost and active investment solution aiming at increasing the protection of their equity pocket in the event of a market downturn. This is based on a combination of two strategies that specifically respond to two types of risk. The first of these is a core Short Bias strategy, which seeks protection against standard market corrections of less than 10% through short and long future and option positions among plain-vanilla, highly liquid and listed indices such as the S&P 500 and the Euro Stoxx 50.

The second is a satellite strategy called Tail Risk, which aims to protect investors against less frequent but more extreme market corrections, i.e. those in the order of 10% or more, through long exposure to volatility futures such as the VIX and the VStoxx. This strategy seeks to take advantage of the positive correlation between the magnitude of a market correction and the volatility peak associated with it, hence the need for long exposure to volatility futures.

A dynamic short exposure solution suits every type of investor, as it fits into a risk management approach. In addition to this, it remains flexible, depending on the level of protection sought, whether this is low or high.

Figure 1: Dynamic short exposure enables dynamic adjustment of the net exposure of an equity portfolio

It goes without saying that a dynamic short exposure solution must also demonstrate its added value in terms of performance, as it seeks out positive alpha over static benchmark indexes. Figure 2 shows the idea of risk reduction against return. So, starting with the same initial portfolio, risk reduction implemented by adding a dynamically managed short exposure (option 2) will target an improvement in the portfolio’s risk/return profile, unlike one which simply reduces its equity exposure (option 1), all things being equal in terms of final exposure level (in this example, 75%).

What does the end of quantitative easing mean for bond investors? What should be the right exposure to emerging bond markets and why are active managers better equipped than passive ones to handle the return of volatility? Mohammed Kazmi, Portfolio Manager & Macro-Strategist Global and Absolute Return Fixed Income at UBP, recently participated in an Asset TV broadcast outlining the risk and reward trade-offs in fixed-income markets over the next six to twelve months.

Bilan (25.09.2018) - “If I had to bet on which would be the leading professions in the years to come, Swiss bankers would be on the list!” This prediction by Laurent Alexandre, the founder of the Doctissimo.fr website, may come as a surprise to some.

Agefi Indices (23.10.2018) - With the exception of oil, the commodity complex as a whole has been struggling since the beginning of the year on concerns about the escalation of the US–China trade war and a stronger US dollar.

Analisi del mercato

19.11.2018

US: deteriorating sentiment in housing

16.11.2018

US production impacted by hurricanes, but sustained activity in business equipment

15.11.2018

US: mixed regional business surveys, but strong retail sales

14.11.2018

Steady inflation trend in the US and the UK; German GDP has contracted more than expected in Q3-18